Thursday, February 10, 2011

The above charts represent the two major components of the CRB Spot Commodity Index. Commodity prices continue to head skyward across the board, with most commodities hitting new all-time highs.

Arab Light Crude, flirting with $100/bbl, is now clearly higher in real terms than it was in the early 1980s. At this level, further price increases should begin to curtail demand, while also stimulating new sources of supply. But we are still well below the levels that might provoke a significant slowdown in economic activity, thanks to technological advances and energy conservation efforts.

Rising commodity prices continue to attest to a) strong global demand, and b) speculative activity fueled by easy/cheap money. Commodities are becoming increasingly vulnerable to any sign that monetary policy may begin to reverse course and seek to push short-term interest rates higher. I don't think this is imminent, but it is the clearest source of risk for commodity investors.

5 comments:

Scott -- I read the January 18 Ron McKinnon WSJ article you recommended in which he argues "speculators can easily bid for long positions in organized commodity futures markets when interest rates are low.” That sounds reasonable, but does it explain the huge recent run-up in commodity prices? Is there also some type of unexplained leverage going on?

lb100: There are lots of ways to speculate on commodities. 1) stockpile them, 2) if you're a producer, leave them in the ground, 3) if you're a financial speculator, buy their futures contracts, 4) add leverage to 1 or 2.

There are also indirect ways to bet on commodities. Buy land. Build buildings. Buy anything that contains commodities (cars, machinery). Buy the currencies of commodity producing countries. Buy the stocks of commodity producers.

All of these actions tend to bid up commodity prices.

Still, I don't think speculation can explain the entire rise in commodities. Strong global growth is a huge factor that can't be ignored.

Scott -- Thanks. This may be implicit, but I would think commodity markets would be less subject to bubbles since their near-term value-cost relationship would be relatively clear. It's more difficult, in contrast, to price "holding" goods such as housing and equities, many of whose benefits will be derived in the distant future. Accordingly, the recent stock market surge may be more likely to reflect speculative exuberance than the corresponding, nearly simultaneous run in the commodity market.